Profile

The Patient Investor

Kathleen Gaffney spent nearly 30 years working with one of the bond world's biggest luminaries. A few months ago, she brought her shrewd analysis and value orientation to Eaton Vance, co-managing its fixed-income allocation fund and heading up a new launch of her own.

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Kathleen Gaffney had her sights set on a job at Fidelity when she graduated from the University of Massachusetts at Amherst in 1983. But that was at the height of the fund industry's heyday; competition was fierce, and the economy was tough. So instead, Gaffney found herself arranging lingerie, from nude to white to black, as a management trainee at Lord & Taylor.

Gaffney didn't last long in her first job. Within months, she returned to Boston and landed an entry-level job at Loomis Sayles. For nearly three decades, she worked at the firm, spending 24 of those years with the legendary fixed-income investor Dan Fuss as he expanded his team and rising to co-manager on the highly rated $84 billion Loomis Sayles Bond Fund. (Asked about his former colleague, Fuss says, "She's a saint because she worked with me for so long.") Early on, Gaffney realized Fuss was going to work "forever," and about 20 years ago she gave him a cartoon of two birds sitting on a branch that suggested the branch couldn't always hold both. It took turning 50 before Gaffney finally flew out of Fuss's shadow. "I wanted the satisfaction of doing it on my own."

So last fall, Gaffney moved three blocks, to head up bond rival Eaton Vance's multisector
Eaton Vance Bond
Fund (ticker: EVBAX), which was launched this year, and she joined Eric Stein on the $2.8 billion
Eaton Vance Strategic Income
Fund (ETSIX). But with veteran investors—herself included—bemoaning the bond market's lofty valuations and warning investors to reassess their bond exposure, it doesn't seem like the best time to start a new fund—especially for a value manager. "I'm a crazy person," Gaffney says.

Veteran investor Kathleen Gaffney is willing to wait for the right opportunities in the bond market.
Jason Grow for Barron's

She's also one of the rare "glass half-full" types in the bond industry. Gaffney buys the idea of a great rotation out of bonds and into equities, given the $1.5 trillion that has poured into fixed-income funds since 2006. People are anchored to the notion that today's low rates are normal, much as they were anchored to the notion that home prices could only go up during the housing boom. But Gaffney says rates are headed higher, and that outflows will be tremendous when the market registers that the economy has real traction—something she expects sooner, rather than later. "It's dicey, but there's opportunity if you have the right tools and experience going into markets when they are breaking—and I do see a lot of breaks coming my way."

Gaffney is preparing for a series of gradual pullbacks in different parts of the fixed-income market. The historically low yields on today's high-yield bonds, she says, suggest a pullback in the next 12 months. "Investors are taking on more interest-rate risk in high yield than they realize," she warns. When interest rates rise and investors start to flee, she is ready with money—36% of the new bond fund is in cash—and a wish list of specific securities she expects investors to dump in the short term, but that she says will prove to be good investments over three to five years.

For both funds, value is at the center of the process. Strategic Income is essentially a fund of funds; Stein takes a macro view, allocating its various portfolio sleeves (which are either Eaton Vance mutual funds or other internally managed portfolios) according to his macroeconomic and political expectations.

Gaffney, however, is focused on the new corporate sleeve, which currently makes up 24% of the fund, and is tasked with specific security selection—bonds, stocks, and convertibles. She looks for companies or sectors that appear cheap but have an improving longer-term outlook, like semiconductor-equipment firms. "Earnings have been depressed because companies have not been spending," she says. "That will change; today's technology is creating greater demand for more chips."

She's also finding good opportunities for income among dividend-paying stocks. Particularly appealing areas include technology and energy, which have been beaten-down, and materials, which offers a less frothy way to play the housing recovery. "There are creative ways of getting access to continued growth in the recovery—you just have to focus on individual companies and the best valuations." For example, she owns bonds of privately held Irish packaging company Ardagh Group.

WITHIN HIGH YIELD, getting the mix between short and long duration is important to limit interest-rate sensitivity when rates start to rise. That takes Gaffney increasingly to the longer-term bonds of "fallen angels"—for instance,
Dell
(DELL), which is trying to go private via a leveraged buyout. "They are not going to be as sensitive to interest rates, because they are driven by the fundamentals of the company. That's the kind of high yield you want." For shorter-term durations, Gaffney also is looking to floating-rate loans, but is wary of those of companies with improving credit, because they are repricing their debt at lower yields, leaving investors little upside.

Gaffney is wary of emerging markets. Recent stars have stumbled, such as Brazil, which is struggling to maintain fiscal discipline and recharge its growth. Ditto the Philippines, which she worries will overheat. "That is sowing the seeds for opportunities down the road," says Gaffney, noting that emerging markets will continue to be attractive, longer-term.

Gaffney expects the specter of rising rates to create short-term opportunities to pounce on for payoff over the next three to five years. "There's no one sector that is a panacea for investors right now," she adds. But that's why she's filling her white board with ideas and waiting to swoop in selectively to make her mark.